exploration and exploitation – Valutrics

Organization that creates value across the knowledge funnel—requires two very different activities: moving across the knowledge stages of the funnel from mystery to heuristic and heuristic to algorithm and operating within each knowledge stage of the funnel by honing and refining an existing heuristic or algorithm. We can map these two different activities onto the theories of the great management theorist James March, who posited that organizations may engage primarily in exploration, the search for new knowledge (in our terms, seeking movement across the knowledge stages), or exploitation, the maximization of payoff from existing knowledge (refinement within a knowledge stage). ⁴ Both activities can create enormous value, and both are critical to the success of any business organization. But they are hard to engage in simultaneously; most often, organizations choose to focus on one activity, either exploration or exploitation, to the exclusion of the other and to their own detriment.

An organization exclusively dedicated to exploration will expire in relatively short order. Typically, exploration alone will not generate the returns needed to fund further exploration. Imagine Norman Greenbaum as a corporation. After the one random incident of successful intuitive thinking, of exploration, that created “Spirit in the Sky,” Greenbaum Inc. would have gone bust waiting for the next chance event—which never happened. Devotion to exploration is the invention of business, a risky proposition and the reason that nine of ten entrepreneurial start-ups expire in less than two years. Exploration alone is unstable business.

On the other hand, many organizations flip quickly from an early exploration phase—the generation of the founding idea behind the business—to the steady exploitation of that idea, never returning to exploration. These organizations, solely dedicated to exploitation, might last somewhat longer than exploration-only businesses, but the business that creates value only through exploitation will exhaust itself in due course. It can’t keep exploiting the same piece of knowledge forever. If it tries to do so, the cost to the business can be devastating.

The exploitation of knowledge within a given stage—that is, running an existing heuristic, gently honing and refining it, but not seeking to move knowledge to an algorithm or running an existing algorithm and not seeking to explore the next mystery—is the administration of business. A high-end Wall Street law firm runs the legal-services heuristic over and over; McDonald’s runs the fast-food algorithm over and over. That is a far different activity from the exploration that drives knowledge from one stage to the next—from mystery to heuristic, from heuristic to algorithm. (See table 1-1.)

TABLE 1-1

Characteristics of exploration and exploitation

	Exploration	Exploitation
Organizational focus	The invention of business	The administration of business
Overriding goal	Dynamically moving from the current knowledge stage to the next	Systematically honing and refining within the current knowledge stage
Driving forces	Intuition, feeling, hypotheses about the future, originality	Analysis, reasoning, data from the past, mastery
Future orientation	Long-term	Short-term
Progress	Uneven, scattered, characterized by false starts and significant leaps forward	Accomplished by measured, careful incremental steps
Risk and reward	High risk, uncertain but potentially high reward	Minimal risk, predictable but smaller rewards
Challenge	Failure to consolidate and exploit returns	Exhaustion and obsolescence

 

The vast majority of businesses follow a common path. The company is birthed through a creative act that converts a mystery to a heuristic through intuitive thinking. It then hones and refines that heuristic through increasingly pervasive analytical thinking and enters a long phase in which the administration of business dominates. And in due course, a competitor stares at the mystery that provided the spark for this company, comes up with a more powerful heuristic, and supplants the original business.

A small fraction of those companies generate a second intuitive breakthrough—often, as in the case of McDonald’s, from a new owner rather than the original entrepreneur—and drive the heuristic to algorithm. These exceptional companies grow to massive size, thanks to the efficiency advantage gained over competitors left behind in the heuristic stage. But they too can fall prey to a new competitor that returns to the original mystery and generates a new heuristic—one powerful enough to overcome even the enormous efficiency advantages of the algorithm. They too can be supplanted in due course.